Wednesday, Sep. 24, 2008

Our View: Attempts at loan oversight need strength

Bills that have already passed the Legislature would be a great start in fixing what has become a dysfunctional system.

California is at the forefront of exotic home loans, the resulting mortgage crisis and ripple effects on unemployment and slowed consumer spending.

The state also should be at the forefront of reversing the Wild West atmosphere driving the mess.

Reckless lending and lax regulation of state-regulated mortgage brokers and lenders helped get us where we are. That is what the state must change.

Assembly Bill 1830, by Assemblyman Ted Lieu, D-Torrance, goes a long way to fix the giant hole in California's supervisory safety net.

Gov. Arnold Schwarzenegger should sign the bill, "one of the most significant bills to pass the Legislature this year," Lieu wrote in a letter to the governor.

The dimensions of the current crisis in the financial system extend far beyond California.

But by strengthening its mortgage laws, the state can help prevent a repeat of the current mess. Doing that entails effectively regulating the mortgage brokers and lenders that caused most of the problems.

AB 1830 is a start, with several key elements:

A Federal Reserve study found that consumers falsely believe that mortgage brokers have a duty to find them the best deal. That belief leads to misplaced borrower trust in the loans they're offered. AB 1830 would create a broker "fiduciary duty" where the economic interest of the borrower must come first.

A major problem in the current marketplace is that mortgage brokers steered borrowers to loans that were riskier and more expensive than those for which they would otherwise qualify based on their income and credit histories. AB 1830 directly prohibits steering.

Another problem: Lenders allowed high-risk borrowers to take on loans with payments that failed to cover even the interest that is due. These "negative amortization" loans result in low initial payments that increase the outstanding balance of the loan over time. AB 1830 bans these loans for borrowers in the subprime market.

The bill puts a cap on costly prepayment penalties that force borrowers to pay thousands of dollars to refinance into a better mortgage loan. FDIC Chairwoman Sheila Bair supports banning these penalties. A cap is less than ideal, but better than nothing.

California has about 30 examiners to oversee nearly 1,100 state-licensed mortgage lenders and about 40 to oversee 548,000 real estate licensees.

That dearth of examiners means borrowers and city and district attorneys should be allowed to bring cases to complement the limited enforcement resources of the state. AB 1830 allows that, called "private right of action."

A small minority, primarily mortgage brokers and real estate agents, opposes the bill. Yet it is clear that California's current laws and enforcement system are insufficient to protect borrowers. Gov. Schwarzenegger should sign this minimal compromise bill.

He also should sign Senate Bill 1737, by Sen. Mike Machado, D-Linden, which offers some back-end enforcement -- suspending bad actors who violate real estate law.

And there's still more to be done. These bills are just a start in reversing the anything-goes market of recent years.

The current financial carnage must not happen again. Mortgage brokers and lenders offering exotic mortgages badly need supervision. AB 1830 helps make that a reality.